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Inflation continues to slow in Europe, UK data due

· GBP lower pre-BOE inflation report tomorrow
· German CPI falls by 0.2% in October as expected
· UK inflation set to fall to 2.5% from 2.7% in September

GBP slipped once again yesterday in the lead-up to tomorrow's Bank of England Inflation Report as more and more investors start to doubt how bullish the Bank of England will be on the UK economy. New growth, inflation and unemployment forecasts are expected and it seems that a positive outcome is not fully priced in with traders now showing a bit of caution.

Those who took part in our Bank of England and ECB webinar on Thursday will have heard us talk about our unease with where markets are starting to price in rate hikes for the UK. Short sterling contracts, bets on what the Bank of England base rate will be at certain points in the future, are currently looking for a 25bps hike in around Q3 of next year. The BOE up until now has been clear about keeping rates low until 2016. Something has to give and this uneasy relationship is the one that holds the key for sterling moving forward.

We will receive the latest news on one of the Bank’s forward guidance ‘knock-outs’ this morning with the publication of the latest CPI data from the UK. Inflation has not been as large a problem as some economists, ourselves included, had originally thought and the news that CPI is slipping closer to 2.0% than 3.0% will come as welcome news to most. The disparity between wages remains clear however, and as a result, we expect inflation to remain under control without Bank of England intervention.

As we said on Friday, the ECB’s decision to cut rates last week will have helped the Bank keep interest rates lower, however. We now have an ECB with a lower “main” rate than the BOE for the first time since 2008. This divergence of monetary policy – a “cutting” ECB and a “hiking” BOE – should engender a higher GBPEUR rate and bring with it a lower CPI rate via lower imported inflation. Lower inflation means less pressure on rates in the short term. That’s our thinking anyway.

CPI is expected at 2.5%, down from 2.7% in September, and is released at 09.30.

Further news from the housing market saw the RICS house price index rise to the highest level in 11 years in October. 57% of chartered surveyors are seeing increasing prices compared to 54% in September with the gap between demand and supply at over a 4½ year high. If supply continues to lag demand by this much, then even a GCSE economics student will be able to tell you what will happen.

Inflation has slipped in Germany once again, increasing chatter about disinflation and eventual deflation in the Eurozone. German CPI slipped by 0.2% with prices rising 1.2% from a year ago. The combination of slowing price increases and disappointing growth numbers due this Thursday are justification enough for the rate cut last week.

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